Compensation Management Approach

A predictable, transparent, and comprehensive approach to reward top employees disproportionately, is a necessary instrument to lead a meritocratic organization. 

Talent in critical functions and in key roles is as important for an organization as intellectual property or product. Talent is the asset that drives forward momentum; most other assets are a reflection of the organization’s past. Ability to retain top talent is dictated by senior executives’ effectiveness in deploying a strong compensation management approach. Employees spend most of their time at work and they expect to be fairly rewarded for their efforts. Otherwise, the best will leave.

What Is Compensation?

Compensation is often linked to monetary schemes like salaries, incentives like bonuses and commissions, and longer-term monetary rewards like stock options. However, vast majority of top-tier employees are also motivated by non-monetary rewards. The importance of such rewards should never be overlooked to ensure that top-tier employees stay on the payroll. Top employees are motivated by 1) immediate internal recognition, 2) possibility of future income through new skills and experiences and 3) in a minority of cases, exposure to new challenges that help the employee grow without any association to other rewards. Practical manifestations of non-monetary rewards are:

  • Organizational positions with greater responsibility and accountability i.e. promotions.
  • Visibility to senior leaders to demonstrate capabilities via invitations to critical meetings and opportunities to present.
  • Opportunity to learn tangible and relevant new skills through lateral moves where employee has no prior experience, but is groomed with an apprenticeship mindset.
  • Remaining employees find motivation when senior executives support top employees to seek growth opportunities external to the company through higher education or stretch roles at other companies.

Seven Common Rewarding Mistakes

Some organizational mistakes are more costly than others. Mistakes around compensation is devastating for a company’s culture. Companies make some common mistakes around compensation and these are compounded by gaps in other concepts under Leadership Approach.

One could try to attribute such mistakes to exception scenarios. However, every aspect under Leadership Approach is about organizational transparency, confidence in senior executives, and predictability. So, even if mistakes only happen in the case of 10% of employees, it undermines confidence in the overall compensation management approach and, thus, senior executives.

‘Squeaky wheel’ fallacy

‘Squeaky wheel gets the grease’ might be the #1 negative behavior reinforcement principle of all time. Organizations often entertain power-plays directly from employees or via their supervisors to secure promotions or incremental monetary compensation outside standard processes and cadence – i.e. Performance Management Approach. This is exacerbated when the company doesn’t have a strong Performance Management Approach. Encouraging one-off negotiations to determine compensation is suboptimal as it is not meritocratic.

Back-channel decisions often take rewards away from top performers who stay focused on their stated goals. An organization should never want top employees to be distracted by the possibility that they might have to negotiate their way to their deserved rewards.

Linear curves are demotivating

For any given runner, improving running speed from 15 mins/mile to 12 mins/mile is a lot easier than improving from 10 mins/mile to 7 mins/mile. The point is higher levels of performance is increasingly harder to achieve as you improve and improvements at higher levels should be rewarded disproportionately.

During a recent discussion with a mid-sized company that struggled with employee motivation, the root cause came down to the compensation structure illustrated above. This is a linear incentive structure and it is not a good idea. It takes much more work for an employee to move from Tier 2 to Tier 1 than Tier 5 to Tier 4. But in this case, their reward for making that improvement would be the same. In such an environment, as individuals, employees are better off targeting a lower tier and taking on external projects that pay them a guaranteed additional wage to cover the incentive. Essentially, the company is incentivizing lower performance.

Tenure-based rewards are unwarranted

Different people have different interests and many of those interests are outside the company walls. In other words, employees have different career goals and different levels of commitment to grow professionally. So, organizations should never feel that salary increases or promotions should align with tenure. Yet, in the absence of a strong performance and compensation management approach, organizations resort to tenure-based rewards. This is a short-cut to ensuring that mid- and low-tier talent stays with the organization, while disappointed top-tier talent departs.

Distortions are the norm; not the exception

Compensation structures are frequently tinkered with or radically modified, especially when a company has growth challenges. The inputs for these modifications tend to be one or two distortions that senior executives observed in the recent past. Including these are important, but it is more critical to ensure that a new distortion is not being created with regards to how various roles work together or how behaviors shift in unanticipated directions.

Imbalance between risk and reward

This is a complex topic that require deeper exploration. At a high level, there should be no “too big to fail” roles or functions in a company. Certain roles are designed to be high individual incentive roles (e.g. sales), while others are low incentive bonus-based roles (e.g. engineering). However, what if the compensation structure is set up where low incentive bonus-based roles don’t get any of their variable compensation when the company misses revenue goals?

This is a common set-up to improve collaboration and somewhat makes sense. But, digging deeper, the high individual incentive roles are also usually tasked with operational processes that directly tie to revenue. Unless carefully designed, the high individual incentive roles will disproportionately benefit when each individual does well. But if they fail as a group, the company will miss targets and they will only do as badly as all other employees in a company. This can drive dissatisfaction and attrition from key functions.

Welfare-state rewarding is unnecessary

Often companies deploy recognition programs where every month or quarter, a few employees are called out as “Rockstars” or “Heroes” and given a small monetary gift in front of other employees. Each time, the recipients tend to be a different set of employees and over time most employees are recognized. Although the intend of such programs is employee satisfaction, top employees will likely feel duped over time. In such circumstances, senior executives have good intentions; but such programs also demonstrate a lack of courage to put top players ahead of mid-tier players. Hence, they are akin to welfare-state recognitions. Top employees are more likely to find this frustrating and leave the company.

History-based compensation is suboptimal

One of the first questions that recruiters often ask is “what is your current salary?”. This is a poor way to start assessing what an employee is worth to a company. A company should have a value determination for every role and position. The people who fit that role should be compensated within an acceptable range of that value. If we assume that the company finds a skilled employee, weighing historic compensation heavily leads to one of three possibilities: 1) the role is being filled by an overpaid employee because of their past high compensation, 2) the role is being filled by an underpaid employee who will eventually realize it and leave the company, or 3) the company gets lucky because a previous employer figured out the right compensation range for the value of the employee. The last option is the least likely outcome and companies should avoid such a compensation determination approach.

Ingredients Of A Strong Compensation Management Approach

Aligning with the string of pearls philosophy, compensation management approach cannot stand alone. It has to dovetail with the company’s strategic and operational plans. But there are some foundational aspects that a company can include to ensure the approach is reasonable.

Performance management outcomes solely dictate rewards

Employees should be able to directly draw a line from their performance management results to their compensation. Although, performance results and compensation decisions are confidential, it is important that the organization maintains transparency about this direct relationship to ensure that all employees are confident that they are not missing out on rewards.

Disproportionately rewards top performers and encourages low performers to resign

Compensation is not just a major rewarding instrument; it is also a perfect mechanism to signal to under-performers about their standing with the company. Companies that get compensation management right is differentiated by their ability to visibly and disproportionately place top performers above mid-tier performers. This allows mid-tier performers to improve. Overtly punishing only obvious poor performers is easy and not enough. The key is to encourage mid-tier employees to push for the top.

Employees are absolutely clear on their compensation packages

Whether it’s understanding how quotas are used in commission calculations or knowing the exact details of bonus decision criteria, employees must be able to easily arrive at their total target compensation themselves and should never be surprised about their final compensation. As simple as this sounds, the most common gap evident from employee interviews is “I don’t understand it!”, especially when compensation plans are radically rebuilt every year.

A strong approach is proactive and set on a cadence

A company needs employees to focus on the strategic initiatives and operational processes built into the goals set for them as part of performance management. This is a lot easier to achieve when specific timelines and cadences are set for compensation discussions and changes.

Benchmarking and rationale for salary bands are transparently shared

Although every employee is responsible for their career, the company (particularly Human Resources) should develop an organizational value proposition to its employees. i.e. the compensation management approach and associated details should articulate the value that the company is giving employees in comparison to similar companies. Not sharing such information will only lead to employee distractions and drive them to perpetually shop around to assess their market value. The company is better off being transparent and allowing employees to focus on their jobs or leave the company faster.

In conclusion, compensation management is a very powerful tool for senior executives to create a meritocratic environment that encourages employees to continuously push the envelope on their performance.

Published By

John Oommen

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